Educational Articles

Dow 30 Earnings: Microsoft – First Quarter Fiscal 2012

Charles Clark
| October 21, 2011

Software giant Microsoft Corp. (MSFT – Free Microsoft Stock Report) started fiscal 2012 (ends June 30th) with good financial results, reporting revenues and earnings of $17.37 billion and $0.68 a share, versus our estimates of $17.50 billion and $0.67. Each of the company's five business segments performed well, though the Online Services Division continued recording red ink. There was not much reaction on Wall Street, as the stock rose marginally in a strongly higher stock market.

Windows 7 remains quite popular, though consumers continue to reach for tablets and smartphones, dampening demand at the retail level. Nonetheless, the business PC upgrade cycle still has legs, likely lasting through the fiscal year, at least. We expect demand from emerging markets to continue topping that from the developed market, as has been the case for some time.

Business seems to be thriving at Server and Tools. Microsoft's strong position in this arena, coupled with the increase in corporate spending on software and related services, are factors underpinning this group's performance. In addition, trends toward more use of virtualization and the desire to handle large amounts of data (''big data'') work in the software vendor's favor. A new release of Windows Server (upcoming) is also a positive.

Moving on, the Microsoft Business Division remains on a roll. Office 2010 has clearly been a success, with businesses (small and large) and consumers both gravitating towards the new office productivity suite. Moreover, Sharepoint, Lync, and Exchange are doing quite nicely, which should help Microsoft's ongoing efforts to expand its communication ecosystem. Last, but not least, Office 365 has gotten off to a strong start, with the ancillary effect being that small businesses are showing increased interest in cloud services.

Meanwhile, there has been a lot of activity at the Entertainment and Devices Division recently. As usual, Xbox/Kinect was a standout, with families and gameplayers continuing to favor the duo over the competition. Elsewhere, the latest update of Windows Phone has been released, with it generally finding good reviews. A broad range of handset makers will be offering products with the new system. In addition, the Skype acquisition was recently closed. Microsoft and its new addition will now go to work weaving Skype's services into its communication ecosystem.

Finally, the Online Services Division is making progress, with Bing picking up market share in search. Nonetheless, the challenge related to monetizing those searches remains. Microsoft and its partner Yahoo! (YHOO) are focused on improving the revenue generated per search (RPS). The reality is Online Services is a high fixed-cost business, and revenue growth is the key to moving into profitability. As an aside, Microsoft has a keen interest in what may transpire at Yahoo!, as that company explores what changes are to be made to its organizational structure. As it stands now, we do not foresee that the partnership would be adversely affected by any changes in structure that Yahoo! may decide to take.

As we have commented before, Microsoft is clearly engaged in moving its products and services more deeply into higher-growth markets. Windows 8 is coming down the pike, and it is making headway in mobile communications. Meanwhile, the holiday lineup looks good for Xbox/Kinect. In brief, then, we expect Microsoft to continue performing well operationally as the year progresses, generating copious cash flow. That said, our revenue and earnings estimates for fiscal 2012 are unchanged, at $74.5 billion and $2.80 a share. Dividend increases and share buybacks should remain on the agenda, supporting the return for shareholders. We continue to advise that this stock is likely to be of most interest to those with an intermediate-time horizon.

About The Company:Microsoft Corp. is the largest independent maker of software. It develops and sells products for a wide range of computing devices. The company also sells the Xbox video game console. Revenue sources in fiscal 2011 were as follows: Microsoft Business, 31.7% of total; Windows & Windows Live, 27.2%; Server and Tools, 24.4%; Entertainment & Devices, 12.7%; Online Services, 3.6%; Other, 0.4%. Research & development spending as a percent of 2011 sales was 12.9%.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.